By Dr Mathieu Despard, UNC-Greenboro (USA)
International Visiting Fellow at CHASM, University of Birmingham
If you are visiting the U.S. and attending a dinner party, here’s a sure-fire way to make evening conversation lively. State one of the following:
- We should cancel all student debt.
- Student debt is a result of poor choices.
Like so much else in social and cultural life in the U.S. these days, these arguments reflect “either or” and zero-sum thinking. Either borrowers in trouble are victims of a rapacious capitalistic system or they are dumb and should suffer the consequences of taking out loans versus working their way through college (one of many iterations of Horatio Alger mythology in the U.S.).
As naïve as this may sound, maybe there is a middle ground that could help U.S. borrowers in distress. And we needn’t look any further than the U.K to see the light at the end of the $1.75 trillion (as of June 2022) student debt tunnel.
Before extolling the virtues of how the U.K handles student loan repayment, a few key facts and findings about U.S. borrowers are in order.
First, the number of older borrowers (age 40+) has grown at 3 times the rate of borrowers under 40 since 2004.
Second, nearly 60% of the 43 million borrowers have outstanding balances of less than $25,000 while a small number of borrowers hold disproportionately high balances but have better labor market outcomes and lower default rates.
Third, at any given time, about 15% of loan balances are in delinquency or default, though certain borrowers are in more trouble than others such as those who attended for-profit colleges. In my research on lower-income borrowers, having student debt increases the chances of financial problems while borrowers who did not finish college are worse off than those who never went and more likely to be African American, female, and have children.
Now, I know what you are thinking – “But wait, doesn’t the U.S. have income-driven repayment (IDR) like the U.K?” Yes, indeed we do. But it’s a wreck. The problems with IDR – and more generally with higher education access and costs in the U.S. – are too lengthy too describe here, but the two main problems are that it is up to borrowers to know about and apply for IDR (loads of friction!) and IDR adjustments just kick the can down the road by extending loan terms rather than forgiving balances – which partially explains the rise in older borrowers.
So that brings me to what I like about the system in the U.K:
- Borrowers start repaying their loans only after their income reaches a certain level (depending on the plan).
- Repayments are automatic via payroll deduction and indexed to earnings (9% of pay above plan threshold amounts).
- Repayments stop if the borrower stops working or their income drops below the threshold.
- Borrowers can request refunds if their income dropped during a repayment period.
- Any remaining amount of debt gets cancelled after making repayments for a certain period.
This system ensures that borrowers pay a fair share of their earnings (excluding the first £27,295 is key) with little friction and ample grace with respect to changes in income. It’s what IDR ought to look like in the U.S., which is theoretically possible given that two major federal agencies – the Internal Revenue Service (IRS) and Department of Education are sitting on the data needed to implement such an approach (emphasis on theoretical).
While the Biden administration’s announcement this week that most borrowers will receive $10,000 in loan forgiveness is welcome news, it’s a measure that fails to address the issue of ensuring the affordability of student loan repayment.
I do see one major flaw in the U.K system. Borrowers must continue payments for 30 years (new borrowers, 40 years). This raises the question of how stretching loan repayment well into prime earning years affects homeownership, family formation, and retirement saving (evidence in the U.S. on these fronts is mixed). And during a period of high inflation, freezing income thresholds and not capping interest at a lower rate isn’t helpful.
Still, the U.K does a much better job than the U.S. in limiting the financial risk of taking on student debt relative to the earnings premium of a college degree. In the U.S., we could reform our IDR system to make repayment automatic and affordable while canceling any remaining debt after a 10-year period.
Lastly, IDR can be used as a mechanism to hold colleges and universities accountable for runaway tuition costs and limit taxpayers’ liability. Colleges and universities who have high amounts of associated student debt that are not being repaid via IDR could then be required to reimburse the Department of Education for what will eventually be part of the cancelation amount.
- More about Dr Mathieu Despard
- More about the Centre for Household Assets and Savings Management
- Back to Business School Blog
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the University of Birmingham.